Knowledge Center: Publication
What China's "new normal" means for multinational companiesSubscribe to Industrial 9/28/2015 Seth Peterson
After nearly two decades of double-digit growth, it is clear that China's economic boom is beginning to slow — a state of affairs that Chinese President Xi Jinping has dubbed China's "new normal." The Chinese government has set a more modest target of 7% annual GDP growth, and the country now enters a phase of restructuring, consolidation, and an economy driven more by innovation than input and investment. The government's goal is to strike a better balance among economic, social, and environmental objectives.
As the global business community adjusts to the new normal, the Chinese economy faces several additional challenges: the continuing weakness in global demand for its exports, rising domestic wages, falling business investment as a result of the rebalancing strategies, sectors with excess capacity, and a softening real estate market. In August 2015, the People’s Bank of China surprised the market by cutting the daily renminbi (RMB) reference rate. A weaker currency could help boost exports, but the absolute impact on Chinese trade balance and growth is likely to be inconsequential over the long term.
Meanwhile, Chinese companies have become more formidable both locally and abroad. Many are going global partly through government-supported campaigns such as "One Belt, One Road," a massive effort to expand linkages from China across Asia to Europe. The initiative primarily aims to promote development in inland China, though it also seeks to absorb excess Chinese manufacturing capacity.
What does all this mean for multinational companies (MNCs) operating in China? Given the rapid rise of the world's second-largest economy, many MNCs now look to their China operations to lead the way in growth opportunities. However, as the country enters a new phase of more moderate growth, its business environment offers new and more intense challenges across different sectors.
As part of an ongoing effort to better understand China’s business environment, Heidrick & Struggles surveyed 119 multinational executives responsible for China operations, with more than half (57%) having a workforce of more than 1,000 employees in China. This is the second year we have conducted this survey. Our findings suggest that most MNCs remain optimistic and expect to see good profitability from their China operations — but they also anticipate the rate of business growth will continue to slow.
Key findings include:
- With the new normal comes new opportunities. A vast majority of survey respondents (78%) believe that China's new normal creates fresh opportunities for foreign businesses. Principally, respondents anticipate opportunities in consumer and service markets, increased emphasis on innovation, greater urbanization, and a more level playing field, strengthened by the government’s ongoing focus on anti-corruption measures.
- However, competition is fierce. Almost 90% of respondents see China as a market characterized by "fierce" competition, with 93% reporting that market conditions have become “increasingly challenging.”
- Sales growth continues, though at a slower pace. Despite challenges, 82% of respondents confirmed their sales increased in 2014, and 75% expect their sales to increase in 2015 (Exhibit 1). In addition, more than 50% of respondents said their profitability has grown so far this year.
- China is a long-term commitment. Organizations with a well-established presence in China report seeing their long-term strategies paying off. This result is despite higher salaries and a more competitive sales environment — factors that are being mitigated by higher efficiency and more productivity.
Given the forecast of continued growth, it is no surprise that a majority of MNCs will continue to invest and increase capacity in China. However, the slowed growth is reflected in our sample’s outlook; just 62% of respondents expect to increase their manufacturing and operating capacity in 2015, down from 83% who expected to increase it in 2014. Only 11% expect to reduce capacity in 2015 (Exhibit 2).
In the face of slowing growth as well as rising labor costs, some companies have implemented hiring freezes. According to our survey, just over half of respondents (51%) expect to increase their head count during 2015, while 26% expect no change. These figures are quite different from last year, when 79% of respondents planned to increase their head count and 14% expected no change (Exhibit 3).
Overall, companies indicate they are going to stay on track with their recruitment objectives, although at a slightly slower pace compared with 2014.
Moving up the supply chain
Despite the slowing rate of growth, most business leaders view China as a long-term growth market that will continue to play an important role in their overall global strategies. Many companies are also upgrading manufacturing facilities to produce higher-margin products and opening innovation centers to focus on R&D activities. To move up the supply chain, 47% of respondents report that their companies have established R&D centers in China. For those enterprises without R&D centers, 9% plan to establish one within the next three years.
It is not only foreign companies that are investing in R&D facilities. To promote manufacturing and national competitiveness, in early March the Chinese government unveiled a “Made in China 2025” strategy intended to establish the country as not just a manufacturer but also a center for innovation and digital technologies.
Operating in a competitive environment
While China remains a key priority for the business leaders we surveyed, the vast majority of respondents (89% in 2014 and 93% in 2015) find that market conditions are more challenging than in previous years. About 90% of respondents in both 2014 and 2015 cited market competition as more intense now than in previous years.
While competition among MNCs is certainly a driving factor, pressure is also being generated by domestic Chinese companies that have raised the quality of their manufacturing and begun to operate in domestic and global market sectors with competitive pricing. Domestic companies are also seemingly able to benefit from the immature capital market by establishing practices without government intervention — or even benefit from government support.
Indeed, Chinese regulations favor domestic businesses ahead of MNCs. The Chinese government is focused on providing incentives to promote domestic consumption and building a more diversified economy. A prime example is Alibaba, which the Chinese government instructed to prioritize working with Chinese companies over foreign enterprises. And yet, more than 50% of respondents still see MNCs as their major competitors. Thirty-four percent view Chinese privately operated enterprises (POEs) as their major competitors.
Other contributing factors to the increasingly competitive Chinese market include higher labor costs and, despite the recent devaluation of the RMB, an increase in the cost of direct and indirect sourcing.
Localizing head count
With the growing pool of high-caliber local talent, the localization of positions held by expatriates holds a high position on the agenda of business leaders interviewed in the survey. However, 50% of respondents — slightly less than the 2014 survey’s rate of 55% — indicated they had no immediate plans to change the number of expatriates they currently have on payroll (Exhibit 4).
The main reason cited for maintaining expatriate head count is that expatriates are needed to further strengthen Chinese business activities, such as grooming local talent to move into more senior-level roles.
Meanwhile, expatriate talent clearly plays an important role, with 15% of respondents (17% in 2014) reporting that they intend to add foreign workers. Many of the increases we see are concentrated in enterprises that intend to expand R&D activities or build on their international customer base. To achieve their objectives, they often require a good balance of international and domestic employees.
Prioritizing talent acquisition and retention
MNCs cite an unprecedented demand for leaders who can manage in more challenging circumstances. Part of the new normal means companies and their leaders must acclimate to heightened competition, greater complexity, and uncertainty, which will require them to think and act more quickly. While the business leaders we surveyed expect the new normal environment will lead to increased competition for talent with Chinese domestic enterprises, they also believe that measures designed to steady economic growth could reduce the level of job-hopping, especially among key talent. This development, they say, would lead to a healthier landscape to develop talent pipelines.
China still core
The challenges that China’s current business environment presents for companies has led some manufacturers to consider investing in additional capacity in countries such as the Philippines, Thailand, and Vietnam. However, our survey results indicate that most MNCs see no other viable "China option" in Asia. The majority of business leaders continue to see China’s opportunities as a core element of their overall strategy, not just in the Asia-Pacific region but also around the globe. Therefore, executives must craft effective approaches to talent to ensure they have quality leaders who can function in this increasingly challenging environment. Since MNCs are primarily in China to tap into its domestic markets, they must develop teams that have the capabilities to seize opportunities beyond the tier-one and tier-two cities. It’s a tall order, but the potential value makes it one that MNCs are eager to pursue.
About the author: Seth Peterson (email@example.com) is a partner in Heidrick & Struggles’ Hong Kong office and a member of the Industrial Practice.